Chinese Premier Li Keqiang speaks during a joint news conference with India's Prime Minister Manmohan Singh at the Great Hall of the People in Beijing October 23, 2013 file photo. REUTERS/Kyodo News/Peng Sun/Pool

Chinese policymakers see securitization as a tool to shift risk away from the banking system to reduce the chances of a financial crisis as economic growth slows and bad loans rise.

Securitization would also help satisfy voracious investor demand for alternatives to the chronically weak stock market and frothy property sector.

Chinese Premier Li Keqiang told a cabinet meeting in late August that China would aggressively expand the securitization of credit assets.

The central bank launched a pilot program in 2005 to allow banks to package loans into bond-like securities known as collateralized loan obligations (CLO).

Authorities have moved slowly on the pilot program though partly in the knowledge that the collapse of collateralized debt, backed by U.S. mortgages, triggered the global financial crisis.

The CLO products available in China make up a tiny fraction of the overall loans market and the involvement of foreign banks will not change that ratio since they hold less than 2 percent of bank assets.

The pilot expansion will be limited to small-scale deals, two sources with direct knowledge of the plan said. Recent deals by domestic banks have ranged from 1-to-10 billion yuan ($164 million to $1.64 billion).

The expanded program is open to all of the 42 foreign banks with locally incorporated branches in China, a grouping that includes HSBC Holdings PLC <0005.HK>, Standard Chartered PLC and Citibank .

"Our company is preparing a plan for (securitizing) financial leasing (assets)," an executive at a foreign bank said. The sources declined to be identified because the expansion of the pilot program has not been officially announced.

Securitization is unlikely to significantly boost foreign bank profits in the near term, but their participation could held China's broader securitization drive.

"If Standard Chartered or HSBC issued a CLO product, its underlying credit assets would probably come mainly from foreign firms, so the asset pool would be more transparent," said a foreign bank executive who previously participated in early CLO deals at a Chinese bank.

Such products would likely be attractive to investors and would therefore serve as a model for domestic lenders to follow, the executive said.

However, foreign banks controlled 1.9 percent of total Chinese banking assets at the end of 2011, according to accounting firm PwC, indicating they have only a limited pool of loans available to create CLOs.

Market participants have previously said lack of transparency of underlying assets is a key barrier to faster growth of securitization in China. Investors are wary of buying assets if they lack the information necessary to assess risks.

That is critical given concerns that the banking system is struggling with an overhang of bad debt from the state-backed lending binge unleashed to help China weather the global financial crisis.

Market participants widely suspect the true scale of the bad debt problem is far larger than the official, system-wide non-performing loan ratio of under 1 percent.

SLOW PROGRESS

About 90 billion yuan ($14.8 billion) of CLO products have been issued in China's interbank market since 2005, according to Reuters calculations based on central bank statements.

That is a tiny fraction of the 70 trillion yuan in local currency loans outstanding at the end of September.

Securitization deals were halted during the financial crisis. The pilot resumed in 2011.

Under the expansion, regulators have asked foreign banks to submit preliminary plans for securitization, the sources said. Once they have received feedback on the preliminary plans, the banks can formally apply for permission to execute the deals.

Banks will be able to choose whether to issue the securitized assets into China's interbank market, where more than 95 percent of all domestic bonds trade, or on the stock exchange, where a small minority of bonds also trade.

Securitization in China has also been hindered by the existence of three separate pilot programs, each controlled by different regulators.

In addition to the CLO program, the China Banking Regulatory Commission overseas an asset management pilot, while the National Association of Financial Market Institutional Investors, overseen by the central bank, is in charge of a program for asset-backed notes.